Greece moves closer to the Eurozone’s exit door

Greece’s economy has been contracting since 2007. In the second quarter of this year GDP was over 6% lower than a year earlier and, according to the OECD, is projected to fall by 5½% overall this year and 1½% next. If the OECD forecasts are accurate Greece’s economy in 2013 will be just over 80% the size it was in 2007.

My hunch is that the OECD is too optimistic. Unemployment was 22% in March and youth unemployment is over 50%, whilst public sector debt is a totally unsustainable 160% of GDP. The Greek economy is imploding.

Greece has received two huge bail-out packages, €110bn in 2010 and €130bn earlier this year, which together amount to more than its annual GDP. (GDP in 2011 was about €220bn.)

A long dissent: Greece's economy has been contracting since 2007

The Greek government has committed to reducing its public sector deficit to a quite unrealistic 2% of GDP by 2014 but in order to try and achieve this target more savage spending cuts will be needed. Unsurprisingly the Greek Prime Minister is currently pleading with the other Eurozone leaders to defer this extra pain, which can only push Greece further and further into recession. But, as yet, his pleas have fallen on deaf ears.

In addition, and crucially, the Greek is quite uncompetitive compared with say the super-competitive German economy. But, locked inside the Eurozone, it cannot get a quick shot of much-needed competitiveness by letting its currency devalue against Germany’s. So the economy struggles, shrinking by the month. This is simply unsustainable.

Of course Greece should leave the Eurozone and return to the drachma. The currency could then depreciate, possibly by 30-40%, and Greek business, not least of all the tourist trade, should recover. I remember well the blood-curdling and apocalyptic warnings about the dire consequences of Britain’s leaving the Exchange Rate Mechanism in 1992, but we left and the economy recovered extraordinarily well.

Pleading for rescue: Greece has received two huge bail-out packages

Greece too must be expected to default on its debts, which is of course bad news for banks (or any other institutions) holding Greek debt. But, if need be, the banks will have to be bailed out or nationalised.

It was reported in the Daily Mail last week that senior Eurozone officials were paving the way for Greece to exit the single currency. This is not before time. Greece’s situation within the Eurozone now looks irretrievable.

In the words of Macbeth “…if it were done when ‘tis done, then ‘twere well it were done quickly.” It is however impossible to say if/when Greece will leave but surely there is at least a 50:50 chance that the country will have exited the Eurozone by the end of the year.

There is much talk about “financial contagion”, meaning that if/when Greece exits the Eurozone, the “markets” will turn their fire on the other weaker southern economies including Portugal, Spain and even Italy, wreaking havoc. Well, maybe. But the Eurozone authorities will surely be prepared for this and it is not a reason for delaying Greece’s exit.

More interesting is the matter of whether a Greek departure, especially when the economy begins to recover, would then be seen as an attractive precedent for other economies trapped in the Eurozone. Who knows? And other countries, from Spain to Finland (for entirely different reasons) may decide their futures are rosier outside rather than inside this flawed and misconceived currency bloc.

It was not meant to be like this of course. Monetary union, as proposed in the Maastricht Treaty, was conceived by European leaders back in the 1980s as a major step towards political unification. Nations were to be subsumed into the European Union with their sovereignty “pooled” (a particularly misleading phrase, nations either have sovereignty or they don’t) and national interests subordinated to European ones.

But national interests have prevailed. There is no sign that the richer countries, principally Germany, have an appetite to sign up to a substantial fiscal transfer union (in which the richer north would subsidise the poorer south on a permanent basis) which is needed to hold the currently configured Eurozone together in the medium-term.

Over the next few years the Eurozone could shrink to a “core” of rich nations or it could break up altogether. The dream of European unity would then lie in tatters.